Loans Back in the Spotlight

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WASHINGTON -- When President Obama made a speech from the Rose Garden on Friday about student loans, it seemed like history was repeating itself. The same thing happened at this time last year: with weeks to go before a scheduled increase in the student loan interest rate, the issue turns into a high-profile political fight.

As Obama acknowledged: “If this sounds like déjà vu all over again, that’s because it is.”

Last year, the interest rate on newly issued subsidized Stafford student loans -- loans that are available only to students with financial need, and that don’t accumulate interest while students are enrolled in college -- was scheduled to double to 6.8 percent on July 1. The increase was long foreseen: Congress passed legislation in 2007 that gradually lowered the interest rate from 6.8 percent to 3.4 percent over five years, but the rate was scheduled to rebound in 2012.

But as concern grew about student debt during last year’s presidential campaign, student groups and the Obama campaign successfully persuaded Congress to pass a one-year extension of the 3.4 percent interest rate, a historic low, at a cost of $6 billion.

Now, though, the year is up, and the interest rate on newly issued subsidized loans will double on July 1 if Congress doesn’t act.

But this year, the debate -- and its politics -- are more complicated.

Both Obama and Congressional Republicans have called for a long-term change to student loans that would allow interest rates to vary from year to year with market conditions -- an idea that the student advocates who mobilized for the “don’t double my rate” campaign last year view with skepticism, at best.

Congressional Democrats, on the other hand, want to extend the 3.4 percent interest rate for another year or two. That would allow them to tackle the interest rate question when they rewrite the Higher Education Act, the law governing federal financial aid programs, which expires at the end of 2013.

In all, at least seven proposals are circulating to overhaul student loan interest rates or postpone the increase.

But in his remarks at the White House on Friday, Obama didn’t get into specifics, instead emphasizing that preventing the increase to 6.8 percent interest rates is the most important thing right now and asking students to call on Congress to make it happen.

“Last year, you convinced 186 Republicans in the House and 24 Republicans in the Senate to work with Democrats to keep student loan rates low,” Obama said. “You made something bipartisan happen in this town. That's a powerful thing.”

Obama’s own plan, proposed in his budget request for the 2014 fiscal year, wasn’t popular with the student activists who led last year’s push to keep the interest rate low and whose help the president called for again on Friday. The president’s plan would peg the interest rate on student loans to the yield on 10-year Treasury bonds, with lower rates for subsidized loans (the 10-year Treasury yield plus 0.93 percentage points) and higher rates for unsubsidized and PLUS loans.

In the short term, subsidized loans under the president’s plan would have lower interest rates than they would even if the 3.4 percent rate remained in effect. And while interest rates for new loans would vary from year to year, they’d be locked in over the life of every loan. That means that if interest rates rose, students would be taking out loans at higher rates, with no cap on how high the rates could go.

While Obama didn’t ask students to push his plan specifically, he also didn’t join Congressional Democrats in calling for another extension of the 3.4 percent rate for another year or two. But he did criticize a bill the House of Representatives passed last week to set student loan interest rates based on the market.

That bill would peg the interest rate on Stafford student loans to the yield on a 10-year Treasury note plus 2.5 percentage points. For PLUS loans for parents and graduate students, the interest rate would be the 10-year Treasury yield plus 4.5 percentage points. Unlike Obama’s plan, the rate would vary from year to year over the life of the loan, although borrowers could lock in a fixed rate after graduation. The House Republican plan also doesn’t offer a lower rate for borrowers of subsidized loans, which Obama’s does. But it does cap the variable interest rates, which can’t surpass 8.5 percent for Stafford loans or 10.5 percent for PLUS loans.

A Congressional Research Service analysis found that, because interest rates are expected to rise, students would pay more under that plan than they would if rates were allowed to increase to 6.8 percent.

“The House bill isn't smart and it's not fair,” Obama said Friday. “I'm glad the House is paying attention to it, but they didn't do it in the right way.”

The legislation that most closely mirrors Obama’s plan comes from Senate Republicans. But with Senate Democrats, including majority leader Harry Reid, supporting another one-year extension of the 3.4 percent interest rate, it’s unclear what -- if anything -- the administration and Congress might agree on before July 1.

The plans:

How is the interest rate determined?

Does rate vary over life of loan?

Is there a cap?

If loan was issued today, what would rate be?

Current law

By Congress. Interest is 3.4% on subsidized Stafford; 6.8% on unsubsidized Stafford; 7.9% on PLUS.